The housing association bond that points to a thawing market
Could a recent flurry of new bonds, including one from Sovereign Network Group, be a sign of things to come in the housing association bond market? Gavriel Hollander reports. Illustration by Lizzie Lomax
Sometimes, even the relatively recent past can feel like an alien world. That is certainly the case when it comes to how housing associations go about financing themselves.
Back in 2008, as the world was reeling from the shock of the biggest financial crisis for generations, housing associations began taking advantage of historically low interest rates to access the long-term bond market like never before. Each bond issue seemed to set a new record for low pricing, with deals regularly making front page news in Inside Housing. After a few years, virtually every medium to large landlord in the country had at least one bond on the market.
According to Butterworths Journal of International Banking and Financial Law, there were around 140 public bonds issued in the social housing sector in the decade after 2008 – more than one a month. Between July 2017 and July 2018, associations raised more than £7.3bn in the debt capital markets, with around three-quarters of that borrowing in the form of public bonds.
But as interest rates finally started to climb again in response to rising inflation in 2021, the days of cheap long-term debt seemed to be numbered. Then, in September 2022, Liz Truss and Kwasi Kwarteng’s infamous Mini Budget spooked the financial markets and the cost of borrowing shot through the roof. All of which explains why there has been some excitement in the sector over a small but potentially significant flurry of activity in the bond market at the start of 2024.
Kicking things off, the newly merged Sovereign Network Group (SNG) raised £400m in January in the shape of a 33-year bond. SNG claims it is the first ‘long-dated’ issue for 14 months – a huge hiatus compared to the heyday of the 2010s. The claim is contestable, depending on your definition of ‘long-dated’, given that Places for People issued an 18-year, £500m bond in November 2023. But either way, these transactions point to a thawing market.
“I think there was a degree of market volatility around rates generally, which is why prior to our issuance in January 2024, there hadn’t been one at the long end of the curve,” says Anup Dholakia, director of corporate finance at SNG. “During the height of that volatility – post ‘Trussonomics’ and what have you – there was an understandable retrenchment from the sector at large in terms of committing to new funding.”
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That volatility has resulted in an environment where the cost of borrowing is higher than even two years ago. Bond pricing is a combination of the cost of government borrowing (the gilt rate) and the credit spread, which amounts to the margin lenders demand over and above gilts. Broadly speaking, while the former element is dictated by timing (issue when base rates are lower and you will get a better rate), the latter is a consequence of how creditworthy lenders deem a particular borrower.
SNG’s deal indicates how times have changed when it comes to borrowing over the longer term, with an overall rate of 5.603% and a credit spread of 108 basis points (bps), or 1.08%. For comparison, in 2019, Sovereign itself raised £375m through a 29-year bond with a credit spread of 127bps, but with an all-in cost of just 2.475%, less than half the price of SNG’s issue.
Since SNG went to the market, others have followed. And each deal reflects this new higher rate environment. In March, BPHA announced the sale of £75m of retained bonds, with an all-in rate of 4.816% and a credit spread of gilts plus 87bps. And April has already seen two larger issuances: Paradigm raising £150m over 20 years, with a 5.295% all-in rate and a spread of 87bps; and Platform Housing Group issuing a 26-year bond for £250m at 5.342%, but with the skinniest spread yet of just 83bps.
These numbers reflect a new reality wherein the credit spread starts seeming far less important when it comes to long-term financial planning than hitting the market at the right time.
“In 2020, when we did see more capital market transactions from the sector, the credit spread had a far greater consequence than today because the gilt yields were so low,” says Chris Evans, a director at Newbridge Advisors, which provides strategic financing advice to housing associations. “Broadly speaking, 50% of your all-in funding cost was the credit spread. Now, the spread only contributes to 20%, so getting your timing right when coming to the market is vital.”
Risk is the name of the game
Despite these significantly more expensive deals, Mr Dholakia says there was little doubt about SNG’s decision to re-enter the bond market.
Since 2022, the association – like most of its peers – has turned to shorter-term revolving credit facilities (RCFs) arranged with traditional banking lenders. While these provide a degree of flexibility, they are generally five-year debt, which means that borrowers have less choice over when to refinance, meaning they could have to do so at a time of even greater interest rate volatility.
“There’s been an over-reliance on banking RCFs and refreshing and recycling them,” he explains. “But that creates a potential cliff edge [when they expire] and doesn’t really manage your refinancing risk.”
And risk is the name of the game for those managing housing association treasuries. Mr Dholakia admits that “price discovery” was the biggest unknown because of uncertainty over how the bonds’ buyers would price a product from a sector that had been relatively dormant. But as long as that pricing is in the business plan, the calculation is that it is worth doing while there is stability.
140
Public bonds issued in the social housing sector from 2008 to 2018
£7.3bn
Debt raised by housing associations in the capital markets between July 2017 and July 2018
And instability is in the air. Even the prospect of a Donald Trump presidency in the US is something that housing association borrowers have to keep in mind. “In terms of interest rate risk… we’re going into a year of elections around the world,” Mr Dholakia says. “There is a lot of kind of intrinsic risk in terms of what that will do to rates, depending on the outcomes.”
At Paradigm, chief financial officer Nicola Ewen agrees with this assessment, especially when it comes to RCFs providing just a short-term reprieve from having to dip a toe into the bond market.
“It’s about aligning with your treasury strategy and managing risks around that,” Ms Ewen explains. “In our 30-year plan, we have interest rate assumptions and stress-test those. RCFs are five years, so at the end of five years, you’re going to have to make an assumption around what’s going to happen and how you’re going to fund it longer term. If you’re looking forward 18 months and there’s another economic shock, you have fewer options at that point.”
She admits that the new interest rate environment has already had an impact on associations’ development plans: “It does change your assumptions in your development appraisals. The cost of funds is linked in to how you would assess a scheme’s viability, and how much you’re willing to pay for that scheme as well. Interest rates are a huge factor in that.”
Another thing that is different this time around in the housing association bond market is the link to sustainable development. The Paradigm and SNG deals are both aligned with the landlords’ sustainable finance frameworks. But while some sustainable bonds were once linked to environmental performance, today they tend to represent a more simple commitment over how the proceeds of the fundraising will be used.
“There was a temptation previously for us to deploy resources towards verifying and assuring stakeholders that we’re social purpose-driven,” Mr Dholakia says of KPI-linked financing, adding that this drive to prove credentials could in some instances have taken resource away from delivering on landlords’ core purpose.
The ESG credentials of the sector – coupled with the income certainty that social rents provide – has always made housing an attractive investment for lenders in the capital markets. And it seems that the relative inactivity of the past two years has created pent-up demand, with both SNG and Paradigm’s bonds nearly four times oversubscribed.
“The deals have priced well and I’ve heard murmurs of other transactions coming forward, so I wouldn’t be surprised to see a flurry in the summer before elections,” says Mr Dholakia. “It’s great for the whole sector and I think it will galvanise others.”
UPDATE 25.4.2024 7.25pm
This story has been updated to remove a quote by Nicola Ewan, chief financial officer at Paradigm. The quote said that a bond issued by the landlord in 2021 included sustainability-linked KPIs. This financing included RFCs as well as bonds, and it was the RFCs, not the bond, which was discounted based on sustainability-linked KPIs.
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